Thursday, June 24, 2010

Peak oil — a crisis postponed

As the global economy goes, so goes oil demand. If the outlook for the global economy is not so good, oil consumption will stagnate or increase very slowly. If oil demand grows slowly or not at all, consumption will remain below the world's productive capacity, as measured in millions of barrels-per-day. If oil demand remains below the available supply, there will be no oil price shock.

A new oil price shock tell us that "peak oil"вЂ”an inability to grow supply to meet growing demandвЂ” has returned with a vengeance. The last time supply could not meet demand was in the years 2005-2007. The growing gap led directly to the oil price shock of 2007-2008. After July of 2008, the world economy unraveled, leading to the relatively low demand environment we have today.

Although this simpleminded explanation smooths out all the messy details, it is basically correct. So where do we stand?

The International Energy Agency has just released its 2010 Medium-Term Outlook reflecting its projections for the period 2010-2015. Here is the relevant text from the summaryвЂ”

Although economic recovery has become reвЂђentrenched, in sharp contrast to last yearвЂ™s backвЂђdrop, concerns persist about its strength and durability. As a result, two oil demand scenarios are again presented. Using May 2010 OMR data as our starting point, we have developed two contrasting views on economic growth, with the lower variant also tempered by weaker assumed efficiency gains. Common features however are the predominance of both the nonвЂђOECD countries and the transportation sector in driving demand growth.

In the higher GDP and efficiency gains case (the base case for our analysis), oil demand grows by an average of 1.2 mb/d annually (1.4%), reaching close to 92 mb/d by 2015. Oil demand recovers to preвЂђcrisis 2007 levels again by 2010. This presupposes GDP growth around 4.5% per year from 2010 onwards (in line with recent IMF projections) and a reduction in oil use intensity of 3% annually, near the level seen in the last five years.

But many voices still envisage a weaker path for global economic growth, amid world trade imbalances and the weakening impact on activity of aggressive fiscal consolidation. This suggests a lower GDP and efficiency gains case. Here, global GDP grows by a weaker 3% annually, while the progress in oil use efficiency is slowed by the weaker investment environment, pushing anticipated reductions in oil use intensity back to the 15вЂђyear average, near 2% per year. In this case, annual oil demand growth averages 840 kb/d (1.0%), taking total global demand to 90 mb/d by 2015, with the re-attainment of 2007 demand levels deferred to 2011.

I am among those who "envisage a weaker path for global economic growth." In so far as the IMF always expects strong growthвЂ”after all, they are run-of-the-mill economistsвЂ”we can safely ignore their projections. This is one set of bureaucrats (at the IEA) predicting a rosy future based on the optimistic views of another set of bureaucrats (the IMF).

I will not lay out the case for my pessimism here, but recent events in the United States (e.g. in the housing market) are among the many indicators of a global economic slowdown. Here's a chart of global growth from Thomas Berner, the Chief US Economist at UBSвЂ”

Source

World GDP is above "potential" (3.5%) but is tailing off. Considering recent events in the United States, China and the Eurozone, it appears that the IEA's 3% low annual growth scenarioвЂ”or perhaps something much worseвЂ”is the best we can expect for the years 2010-2012.

The low growth scenario has oil demand growing at 1% per year (840,000 barrels-per-day) and assumes that oil intensity reductions are smaller than in recent years. That takes us to 90 million barrels-per-day (all liquids) in 2015. "All liquids" means any liquid fuel type, not just crude oil (e.g. biofuels, gas liquids). The IEA's term "oil" is a short hand for all liquids. (There will be a quiz later.)

In my view, the world will never produce 90 million barrels of liquid fuels on a daily basis. But I wouldn't mind being wrongвЂ”maybe we'll get to 91 or 92. These are mere details in the Grand Scheme of Things. The longer term outlook remains bleak. Sticking to my current view of never 90, that puts the next oil price shock nearer to the end of the 2010-2015 period than its beginning.

Thus I tentatively conclude that "peak oil" is a crisis postponed. Actually, I am fairly confident about this prediction, but it is always wise to hedge your bets. Nevertheless, I am going to wait few months before I update my own "official" estimate of the situation as laid out in The Next Oil Price Shock. When I do update it, I will likely push out the date of the next price shock one year to 2013 В± 1 year. If the global economy goes all to hell next year, I will push the date out further to 2014 В± 1 year.

Many of those concerned about the oil supply write or speak as though The End Is Near, or The End Is HereвЂ”I will not name names, although Matt Simmons comes to mind. Needless to say, I have seen many predictions of the Oil Apocalypse come & go.

The End Is Near, but not quite as close as some people think. On human timescales, which tend to be quite short, the deteriorating state of the global economy has bought us some time. I seriously doubt that governments will make wise use of that time. Preparing for the ongoing oil crisis would be a huge departure from their normal behavior, which here in the United States, consists mostly of making matters worse and then telling The People not to believe what they can plainly see right in front of them.